The Future Is Now: A Balanced Plan to Stabilize Public Debt and Promote Economic Growth

Spurred by the financial crisis, a painfully slow recovery, and inexorable demographic change, the federal budget is on an unsustainable path. Debt held by the public, which historically has averaged less than 40 percent of GDP, currently stands above 60 percent and is poised to climb rapidly. Under the President’s proposed budget, the budget deficit would average 5.2 percent of GDP over the next decade—a level that would not only fail to help bring the debt back down to pre-crisis levels but would keep it growing much faster than the economy. Under the proposed budget, the public debt to GDP ratio would reach 70 percent by 2011, 90 percent by 2020, and would break the World War II record of 109 percent just a few years after that before soaring to unimaginable levels during the ensuing decades.

Some downplay deficits and debt as a green-eyeshade concern disconnected from the real economy. We disagree. As we read the evidence, excessive levels of public debt harm the economy in multiple ways.

As the economy recovers, excessive public debt competes with private sector demands for capital, raising interest rates for all borrowers, including the government, and leading to slower economic growth.

As debt accumulates and interest rates rise back to historical levels (or beyond), interest payments on the federal debt will soar, competing with other important priorities.

Because so much U.S. public debt is held by non-American individuals and institutions, interest payments on that debt represent a substantial transfer of income and wealth out of the American economy.

Excessively high debt levels lead to increased risk of a fiscal crisis in which investor concerns lead to abrupt spikes in interest rates and a vicious debt spiral. By the same token, such debt levels reduce the federal government’s ability to respond fully and flexibly to severe crises.

While the economy struggles to recover from the recent recession, it would be premature to start implementing aggressive deficit reduction measures. However, policymakers should commit as quickly as possible to a plan—phased in as soon as the economy permits—to stabilize the debt at a healthier and more sustainable level by the end of the decade and to set it on the kind of downward course we enjoyed for much of the post-World War II period.

Some believe that fiscal discipline would reduce the rate of economic growth. Again, we disagree. The evidence from the United States in the 1990s as well as from many European countries in recent decades suggests that implemented prudently, a plan for fiscal restraint could actually promote long-term economic growth. The reasons are straightforward: not only would interest rates be lower than they otherwise would be, but in addition, the private sector would respond to a more stable and predictable economic climate by making long-term commitments that would not occur in less favorable circumstances.

A final area of disagreement: many political leaders, policy experts, interest groups, and ordinary citizens believe that the fiscal stabilization we recommend will necessarily reduce protections for the most vulnerable members of our society and could undermine the broad-based coalitions needed to sustain core programs of the New Deal and Great Society. We believe, on the contrary, that stabilization done right can actually increase security and decency for those most in need of assistance—without undermining the support of the more fortunate for the programs that make this possible. (We spell out the meaning of “done right” below.)

The main obstacle to a viable debt reduction plan is neither economic nor moral, but political. As most people privately understand (and some publicly admit), such a plan will require significant budgetary changes, including wide-ranging spending cuts and substantial revenue increases. In today’s polarized political environment, where even politicians who emphasize the importance of fiscally responsible policies are hesitant to get specific, putting together a comprehensive fiscal plan is extremely difficult.

In this unpromising context, it is useful for outsiders who do not labor under the same political constraints to put forward specific proposals, helping pave the way for a more realistic conversation among policymakers. While every feature of our plan is legitimately debatable, one thing is clear: continuing to focus on manifestly unrealistic policies—whether promising to solve the problem by cutting “waste, fraud, and abuse,” making no-tax pledges, or taking the largest areas of spending such as defense or Social Security off the table—will only prolong an era of evasion that has gone on much too long.

We believe that the American people want their leaders to treat them like adults who are capable of accepting the truth. But this cannot happen until our leaders begin to act like adults who are interested in solving problems rather than scoring political points. We offer this plan as a modest contribution to a better conversation about our common future.

Promote shared sacrifice. The gap we face is just too large to close if we declare significant areas of the budget off-limits. Moreover, no plan without bipartisan support will be viable, and neither party is going to sacrifice only the areas of the budget it most cares about in the absence of corresponding concessions from the other side.

Encourage growth. Although we will not be able to grow our way out of the nation’s fiscal problems, higher levels of economic growth will make the task much easier by increasing revenue coming into the Treasury and by making necessary policy changes easier to bear. We should therefore do our best to protect or even increase spending in such areas as public investment and education, that yield the highest economic returns, and we should minimize tax increases on things that we want to encourage, such as work and investment.

Protect those in need and increase progressivity. The problem of growing income inequality in this country is serious. Many segments of our population have not shared in the economic growth over the past generation and are particularly vulnerable right now. We should keep in place—and in some cases beef up—a strong safety net and critical insurance programs to protect the most vulnerable.Consistent with other principles and goals (such as economic growth) changes in both spending programs and taxation should reflect the varying abilities of individuals to bear additional burdens and responsibilities without excessive sacrifice.

Enhance the transparency of our spending priorities. Important features of our current budget terminology and procedures have the effect of obscuring what is really at stake. For example, much of our tax code represents back-door outlays through “tax expenditures.” Restricting tax expenditures is therefore a necessary part of any effort to cut spending as well as a central component of fundamental tax reform.

Acknowledge demographic and health care realities. Changing demographics and growing health care costs create the major long-term fiscal challenge in this country—as well as in many others. Over the next couple of decades, as the baby boomers retire, the number of elderly Americans will soar both in absolute numbers and as a share of the total population; this trend will continue as life expectancy continues to rise. This will drive up costs in retirement and health care programs. No budget plan will be sustainable if it does not tackle these challenges head on. That said, it is also unreasonable—given the greater dependence of the elderly on public programs—to think that we will be able to keep federal spending at or below historical levels.

Two final points. First, our fiscal challenge calls for more than an arithmetic process of adjusting taxing and spending to meet numerical targets. We have both the need and the opportunity to rethink the way we promote our goals and honor our principles in circumstances very different from those in which our current commitments were made. Our watchword should be not retrenchment but rather reform.

Second: a budget should be just that—a budget. We cannot hope to live within our means unless we are able to determine acceptable levels of taxing and spending and adjust our policies to fit them. Open-ended claims, whether for direct outlays or tax subsidies, are incompatible with effective budgeting. We recognize the need for longer time horizons in both entitlement programs and tax policy. But we cannot afford to place these portions of our budget on auto-pilot and insulate them from unanticipated developments. For this reason, we need mechanisms that require elected officials to make needed adjustments when these crucial sectors diverge from their projected fiscal path.[1]

[1]
For one example of how to do this, see “Taking Back Our Fiscal Future” (Brookings and the Heritage Foundation, 2008). Although this document applies the new budgetary procedures to entitlement programs, there is every reason to treat tax expenditures in the same manner. That is what we recommend.